Saving only $100 per month from age 25 to age 65
at 12% growth = $1,176,000. Everyone should retire a millionaire!
- Dave Ramsey
Term Insurance vs. Permanent Insurance
When debating their options for financial and life insurance needs, some families may ask, “Why should I buy permanent insurance when I can buy term and invest the difference?” As you may already know, ‘buying term and investing the difference’ refers to the strategy of comparing the cost of a permanent life insurance policy to a term life insurance policy with the same death benefit, and investing the cost difference in the stock market rather than allowing it to accumulate as cash value within the life policy.
The key features and variations of these two planning strategies may make them attractive to different families depending on their personal situation. However permanent insurance guarantees that the policyholder will be able to protect their family’s financial situation no matter when they die.
The “Expert” Opinion on Term Insurance
Dave Ramsey, the self-proclaimed financial guru and proponent for “buying term and investing the difference,” has claimed that if a 30-year-old male had $100 a month to spend on life insurance, the amount of coverage that he could buy on a permanent policy would be about $125,000. To get the same amount of coverage on a 20-year-term life insurance policy, it would only cost him about $7.00 per month. That would leave him a $93.00 that he could invest or save in some other format, according to Ramsey.1
The key argument in favor of ‘buying term and investing the difference’ is: because the money a policyholder is investing is not being used in part to pay life insurance premiums, they will be able to generate a more efficient return. However, investing wisely is a key factor in determining the success of this strategy.
Ramsey backed up his argument with the claim that “Saving only $100 per month from age 25 to age 65 at 12% growth = $1,176,000. Everyone should retire a millionaire!”2
Using Ramsey’s calculations, if the 30-year-old male buys term insurance and invests the $93 difference, by age 50, when his term period expires, he will have accumulated $80,638.42.* It is important to note that less than 5 percent of men are likely to die between age 30 and age 50, according to an article published by BusinessInsider.3 Meaning it is highly unlikely that his family will ever see the death benefit from his term insurance policy.
Unfortunately, the expectation to accumulate a 12 percent return is hopeful at best. According to a study conducted by “Dalbar's 2015 Quantitative Analysis of Investor Behavior,” over 20-year period, ending Dec. 31, 2013, the average investor (in all varieties of mutual funds) only managed an average total return of about 2.5%4 So using Dave Ramsey’s method of Buying Term and investing the difference, at a realistic 2.5% rate of return, this 30-year-old male would end up with only $29,774.94, instead of $80,638.42.** Even at 6% he will only accumulate $42,367.93. And if he wishes to continue receiving insurance coverage after his term period has ended, he can expect to incur much higher premiums due to their change in age and overall health. Moreover, he may even be denied coverage if his health has deteriorated significantly. To reiterate, at age 50, the man in this example, should he “Buy Term and Invest the Difference,” will likely have less than $30,000 in savings and no life insurance coverage whatsoever.
*Assuming 12% rate of return and 15% tax on gains
**Assuming 2.5% rate of return and 15%tax on gains.
Which Life Insurance Option is Best for You?
New products have been released that may provide a better solution for the man in Dave Ramsey’s example. Some carriers now offer Guaranteed Universal Life Insurance (GUL) products that offer guaranteed life-time death benefit protection and the option to cash-out your policy should your needs change in the future. If your circumstances change or you no longer need life insurance, a new Guaranteed Cash-Out Rider may be your way to restore financial stability. On the 15th, 20th and 25th policy anniversaries, the rider allows you to surrender your policy and receive a partial or full return of your premiums paid.
If the same man mentioned previously were to put all of his $100 per month budget into a GUL with a Guaranteed Cash-Out Rider, he would be able to qualify for approximately $300,000 of death benefit, more than twice the coverage of the man buying term insurance in Ramsey’s example.***
Additionally, with a Guaranteed Cash OutRider, should he decide he does not need life insurance anymore, he can surrender the policy at age 55 and receive $30,000 from the policy. Leaving him in the same financial position as the man in Ramsey’s example. But should the SGUL policyholder wish to continue his insurance coverage, he simply continues paying his $100 premium and is guaranteed $300,000 in death benefit. Whereas the man in Ramsey’s example is almost certainly to incur substantially higher premiums and runs the risk of being denied coverage if he wants to buy more life insurance.
Ultimately, a person who wants to purchase either of these products should consider all their options and seek the advice of an independent financial or insurance professional to decide which method is right for their personal situation. However, “buy term and invest the difference” provides an arguably inferior insurance product, in addition to possibly a riskier investment portfolio. A GUL along with a Guaranteed Cash-Out Rider assures that the man in this example will be able to protect his family’s financial status after he dies. Additionally, if his needs change and he decides that he no longer needs life insurance coverage, he can cash out on his policy and invest his using a different financial strategy